So, we have been through the first two steps of ‘How to Invest Safely’ series.
Now we look at the difference between ‘Saving’ and ‘Investing’, and which is right for you. These terms may sound very similar, but are very different in reality.
Be careful not to mix up the two. Do what is right for your particular situation. If in doubt, ask me what’s right for you.
‘Saving’, is for people who want to accumulate money towards a particular goal, could be ‘saving for children’s college fees’, or ‘saving for old-age independence’, or ‘saving to buy a home’, etc…
In most cases, people are ‘saving’ money for some time in the future. Since ‘Saving in a bank account’, does not beat inflation, most people tend to save in ‘Regular Savings Plans’, that offer some kind of underlying investment to beat inflation, i.e. mutual funds or index funds. For more information read the following:
‘Investing’ is a different beast altogether. This is mostly for people who have a lump sum amount of money accumulated already, and want to get returns better than inflation on it.
More often than not, the objective is to ‘Protect’ the money’ that has been saved over a number of years, or a lump sum received from any source.
Note: When investing a lump sum the amount of money, consider the fact that you may not have the latest and most up-to-date information on the different types of investments out there. Always seek expert advice first, then use your judgement.
Probably the most important and most underrated factor of all is the ‘investment term’. ‘Investment term’ is nothing but the amount of time after which you need your money back.
More often than not, people make mistakes with this decision and regret it, after losing money. The investment term will dictate, what kind of investment instrument you can get into:
- Bank accounts are the safest place for an investment term of upto 1 year.
- If you have 1 to 3 years, before you need the money, consider some sort of fixed income investment like Fixed Deposits, Government Bonds or Index based Structured notes.
- With an investment term of 3 to 5 years, you are better of with a portfolio of index funds (ETFs) and Structured Notes.
- With 5+ years, you can take higher risk, (in return for higher returns) and get into a diverse portfolio that includes all the asset classes mentioned in the 3 musketeers article.
Risk profile is the ability of an investor to absorb risk. Risk is omni-present, managing risk is key. When you take money out of your pocket and give it to anyone, ‘There is risk’.
The amount of risk depends on ‘Who you give it to’, ‘Their financial strength’, ‘Their ability to pay you back, within the stipulated amount of time’, and ‘What they intend to do with your money’.
The same applies to investing. ‘Who you give it to’, and ‘financial strength’ talks about the organisation you are lending the money to. ‘Ability to pay you back’ is their credit worthiness. ‘Stipulated amount of time’ dictates, what they can do with your money.
‘What they intend to do with your money’, relates to the type of investment. In summary, ‘high risk = high returns / loss’, ‘medium risk = medium returns / loss’, and ‘low risk = low returns / loss’.
Your Financial Advisor
Again, I cannot stress enough - ‘Don’t pull out your own tooth, get expert advice'. There is reason why financial advisors exist.
When in doubt, try and find a financial advisor through your friends, colleagues and relative’s recommendations. A good financial advisor will not cold-call you.
Here is an article on ‘How to choose a financial advisor’.